Exam 8: Risk and Return

A) If a stock has a negative beta, its required return under the CAPM would be less than 5%.
B) If a stock's beta doubled, its required return under the CAPM would also double.
C) If a stock's beta doubled, its required return under the CAPM would more than double.
D) If a stock's beta were 1.0, its required return under the CAPM would be 5%.
E) If a stock's beta were less than 1.0, its required return under the CAPM would be less than 5%.

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A) The riskiness of the portfolio is greater than the riskiness of each of the stocks if each was held in isolation.
B) The riskiness of the portfolio is the same as the riskiness of each stock if it was held in isolation.
C) The beta of the portfolio is less than the weighted average of the betas of the individual stocks.
D) The beta of the portfolio is equal to the weighted average of the betas of the individual stocks.
E) The beta of the portfolio is larger than the weighted average of the betas of the individual stocks.

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False

A) An investor can eliminate virtually all market risk if he or she holds a very large and well diversified portfolio of stocks.
B) The higher the correlation between the stocks in a portfolio, the lower the risk inherent in the portfolio.
C) It is impossible to have a situation where the market risk of a single stock is less than that of a portfolio that includes the stock.
D) Once a portfolio has about 40 stocks, adding additional stocks will not reduce its risk by even a small amount.
E) An investor can eliminate virtually all diversifiable risk if he or she holds a very large, well-diversified portfolio of stocks.

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A) Portfolio P has a standard deviation of 25% and a beta of 1.0.
B) Based on the information we are given, and assuming those are the views of the marginal investor, it is apparent that the two stocks are in equilibrium.
C) Portfolio P has more market risk than Stock A but less market risk than B.
D) Stock A should have a higher expected return than Stock B as viewed by the marginal investor.
E) Portfolio P has a coefficient of variation equal to 2.5.

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A) The required return on a stock with beta = 1.0 will not change.
B) The required return on a stock with beta > 1.0 will increase.
C) The return on "the market" will remain constant.
D) The return on "the market" will increase.
E) The required return on a stock with a positive beta < 1.0 will decline.

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E

A) Collections Inc. is in the business of collecting past-due accounts for other companies, i.e., it is a collection agency. Collections' revenues, profits, and stock price tend to rise during recessions. This suggests that Collections Inc.'s beta should be quite high, say 2.0, because it does so much better than most other companies when the economy is weak.
B) Suppose the returns on two stocks are negatively correlated. One has a beta of 1.2 as determined in a regression analysis using data for the last 5 years, while the other has a beta of -0.6. The returns on the stock with the negative beta must have been negatively correlated with returns on most other stocks during that 5-year period.
C) Suppose you are managing a stock portfolio, and you have information that leads you to believe the stock market is likely to be very strong in the immediate future. That is, you are convinced that the market is about to rise sharply. You should sell your high-beta stocks and buy low-beta stocks in order to take advantage of the expected market move.
D) You think that investor sentiment is about to change, and investors are about to become more risk averse. This suggests that you should rebalance your portfolio to include more high-beta stocks.
E) If the market risk premium remains constant, but the risk-free rate declines, then the required returns on low-beta stocks will rise while those on high-beta stocks will decline.

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A) 9.41%
B) 9.65%
C) 9.90%
D) 10.15%
E) 10.40%

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A) Company X has more diversifiable risk than Company Y.
B) Company X has a lower coefficient of variation than Company Y.
C) Company X has less market risk than Company Y.
D) Company X's returns will be negative when Y's returns are positive.
E) Company X's stock is a better buy than Company Y's stock.

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A) The required return of all stocks will increase by the amount of the increase in the risk-free rate.
B) The required return will decline for stocks that have a beta less than 1.0 but will increase for stocks that have a beta greater than 1.0.
C) Since the overall return on the market stays constant, the required return on each individual stock will also remain constant.
D) The required return will increase for stocks that have a beta less than 1.0 but decline for stocks that have a beta greater than 1.0.
E) The required return of all stocks will fall by the amount of the decline in the market risk premium.

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A) Portfolio P has a standard deviation of 20%.
B) The required return on Portfolio P is equal to the market risk premium (rM − rRF) .
C) Portfolio P has a beta of 0.7.
D) Portfolio P has a beta of 1.0 and a required return that is equal to the riskless rate, rRF.
E) Portfolio P has the same required return as the market (rM) .

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A) The slope of the SML is determined by the value of beta.
B) The SML shows the relationship between companies' required returns and their diversifiable risks. The slope and intercept of this line cannot be influenced by a firm's managers, but the position of the company on the line can be influenced by its managers.
C) Suppose you plotted the returns of a given stock against those of the market, and you found that the slope of the regression line was negative. The CAPM would indicate that the required rate of return on the stock should be less than the risk-free rate for a well diversified investor, assuming investors expect the observed relationship to continue on into the future.
D) If investors become less risk averse, the slope of the Security Market Line will increase.
E) If a company increases its use of debt, this is likely to cause the slope of its SML to increase, indicating a higher required return on the stock.

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False